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Homebuilders Are Overvalued and Overbought

Stocks in this article: HGX DHI HOV KBH LEN PHM SPF TOL

NEW YORK ( TheStreet) -- The housing data we have seen in recent months has been favorable. Homebuilder confidence has been on the rise along with housing starts, building permits and new home sales.

These improving trends need to continue in order to bring the market for new homes back to normal. In this environment homebuilder stocks may have rallied too far too fast.

There are numerous hurdles that must be cleared for the construction of new homes to contribute to economic growth and to create good-paying jobs.

First of all, www.ValuEngine.com shows the construction sector is the most overvalued by 18.4%.

In addition, my benchmark for the sector, the PHLX Housing Sector Index (HGX) shows a potential triple-top on its daily chart, and is extremely overbought on its weekly chart, and has been overbought since the week of August 10. HGX has surged 125.5% since October 2011, and is up by 61.4% year to date.

Recent data on the housing market continue to show steady improvements in the market for new homes.

The National Association of Home Builders reported its Housing Market Index, a measure of builder confidence, rose a point to 41 in October as serious buyers visited sales offices around the country. The HMI has been rebounding for six consecutive months, but it remains below the neutral reading of 50, so it really means that builders are becoming less pessimistic.

Housing starts surged 15% in September with an 11% gain in single-family starts. New home construction rose to a seasonally adjusted annual rate of 872,000 units with permits up 11.6% to 894,000 units. The important single-family starts posted an annual rate of 603,000 units. These are the strongest numbers since July 2008.

While this pace is encouraging, the market for new homes is far from fully recovered. At best new home construction is at 50% of what would be described as a normal market. This may have stabilized employment in the construction industry, but is not generating additional job growth and is only making a dent at best in economic growth.

New home sales rose 5.7% in September to an annual rate of 389,000, the highest level since April 2010. The average price was up 11.7% year over year to $242,400. The unsold inventory rose 2,000 to 145,000, which is bouncing around a record low and only a 4.5-month supply at the current sales pace.

The S&P/Case-Shiller Home Price indices showed that the 20-City Composite was up 1.6% in July vs. June 2012, up 1.2% year over year and up 7.8% since the recent low. Home prices are still down 30% from the June/July 2006 housing market bubble peak.

The daily chart for PHLX Housing Sector Index (166.11) shows the triple-top on Sept. 21, Oct. 5 and Oct. 18 with the multi-year high at 169.56. HGX is above its 21-day, 50-day and 200-day simple moving averages at 162.22, 154.89 and 133.51. The 50% retracement of the entire collapse from mid-2005 to March 2009 is 173.81.

My monthly, quarterly and annual value levels are 158.83, 145.84 and 122.53 with this week's risky level at 174.90.

Chart Courtesy of Thomson/Reuters

The roadblocks to a fully healthy market for new homes include:

  • Too many underwater homeowners who would like to move up to a new home but can't
  • Elevated OREO at community and regional banks and at Fannie Mae and Freddie Mac that will eventually provide competing additional inventory of existing homes
  • The still-elevated level of construction and development loans on the books of community banks, which stifles lending to home builders who wish to rebuild inventories
  • The FDIC still has more than 700 banks on their list of problem banks
  • Tight credit conditions for home buyers looking for a mortgage
  • Sketchy home appraisals continue to make deal closing problematic
  • Mortgage applications fell 12% in the week ending October 19

    Investing in the homebuilder stocks remains highly speculative, as I wrote in Homebuilders' Valuations Are Extremely Speculative back on Sept 27. Here are my updated profiles for the homebuilders.

    Reading the Table

    OV/UN Valued: The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage according to ValuEngine.

    VE Rating: A "1-Engine" rating is a Strong Sell, a "2-Engine" rating is a sell, a "3-Engine" rating is a hold, a "4-Engine" rating is a buy and a "5-Engine" rating is a strong buy.

    Last 12-Month Return (%): Stocks with a red number declined by that percentage over the last 12 months. Stocks with a Black number increased by that percentage.

    Forecast 1-Year Return: Stocks with a red number are projected to decline by that percentage over the next 12 months. Stocks with a black number are projected to move higher by that percentage over the next 12 months.

    Value Level: The price at which to enter a GTC Limit Order to buy on weakness. The letters mean; W-Weekly, M-Monthly, Q-Quarterly, S-Semiannual and A- Annual.

    Pivot: A level between a value level and risky level that should be a magnet during the time frame noted.

    Risky Level: The price at which to enter a GTC Limit Order to sell on strength.

    D.R. Horton (DHI) ($21.41 vs. $20.90 on Sept. 27) still has a buy rating according to ValuEngine and is above its 200-day SMA at $17.08. Book profits against my monthly pivot at $21.35, and then employ a "buy and trade" strategy between the value level and risky level.

    Hovnanian (HOV) ($4.44 vs. $3.43 on Sept. 27) has been upgraded to hold from sell according to ValuEngine and is above its 200-day SMA at $2.67. Investors and traders should employ a "buy and trade" strategy between the value level and risky level.

    KB Home (KBH) ($16.72 vs. $13.90 on Sept. 27) still has a hold rating according to ValuEngine and is above its 200-day SMA at $10.40. Book profits on strength to my weekly pivot at $17.96, and then employ a "buy and trade" strategy between the value level and risky level.

    Lennar (LEN) ($38.20 vs. $34.64 on Sept. 27) still has a buy rating according to ValuEngine and is above its 200-day SMA at $28.66. Book profits versus my monthly pivot at $37.99, and then employ a "buy and trade" strategy between the value level and risky level.

    Pulte Group (PHM) ($17.45 versus $15.30 on Sept 27) has been upgraded to Strong Buy from Buy according to ValuEngine and is above its 200-day SMA at $10.84. Investors and traders should employ a "buy and trade" strategy between the value level and risky level. I show an annual risky level at $26.56.

    Pulte reported their third quarter earnings report pre-market this morning. Their EPS was in-line with estimates at $0.30 with a miss on the revenue line at $1.3 billion versus the $1.4 billion estimate.

    Ryland Group (RYL) ($32.79 vs. $30.01 on Sept. 27) still has a buy rating according to ValuEngine and is above its 200-day SMA at $23.35. Investors and traders should employ a "buy and trade" strategy between the value level and risky level.

    Standard & Pacific (SPF) ($7.79 vs. $6.80 on Sept. 27) has been downgraded to hold from buy according to ValuEngine and is above its 200-day SMA at $5.50. Book profits vs. my monthly pivot at $7.72 and weekly risky level at $7.83.

    Toll Brothers (TOL) ($35.25 vs. $34.16 on Sept. 27) still has a buy rating according to ValuEngine and is above its 200-day SMA at $27.67. Book profits at my monthly pivot at $35.57, then employ a "buy and trade" strategy between the value level and risky level.

    Note that six of the eight stocks are overvalued by 16.5% (RYL) to 69.5% (LEN). All have had huge price gains over the past 12 months led by a 234.9% gain for PHM. The projected gains for the next 12 months dwarf the performance the past 12 with a forecast gain of 12.2% for PHM.

    Two of the eight stocks do not have P/E ratios. The other six have elevated 12-month forward P/E's between 21.4 (PHM) to 36.3 (TOL). Normally the homebuilders should have high single-digit P/E ratios.

    At the time of publication, the author held no positions in any of the stocks mentioned.

    This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

    Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.

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